Learning Objectives

1. Learning Objectives • Discuss the importance of unit costs. • Describe functional-based costing approaches. • Explain why functional-based costing approaches may produce distorted costs. • Explain how an activity-based costing system works.

2. Learning Objectives (continued) • Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates. • Describe the role of activity-based costing for organizations with only one product, homogeneous products, or a JIT structure.

3. Unit Costs The unit costis the total cost associated with the units produced divided by the number of units produced Although the concept is simple, the practical reality of the computation can be somewhat more complex because of the following issues: • What is meant by “total cost”? • How do we measure the costs to be assigned? • How do we assign costs to the product?

4. Unit Costs (continued) Unit costs are important for: • inventory valuation • income determination • providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders

5. Measurement Systems Two possible measurement systems are actual costing and normal costing. Actual costingassigns the actual costs of direct materials, direct labour, and overhead to products. Normal costingassigns the actual costs of direct materials and direct labour to products; however, overhead cots are assigned to products using predetermined rates.

6. Activity Capacity Measures Units (of driver) Theoretical Practical Expected actual Normal Time

7. Functional-Based Costing:Plantwide Rate Overhead Costs Assign Costs Direct Tracing Plantwide Pool Stage One: Pool Formation Assign Costs Unit-Level Driver Products Stage Two: Costs Assigned

8. Belring, Inc. Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following actual and budgeted data: Budgeted overhead $360,000 Expected activity (DLH) 100,000 Actual activity (DLH) 100,000 Actual overhead $380,000

9. Belring, Inc. (continued) CordlessRegular Units produced 10,000 100,000 Prime costs $78,000 $738,000 Direct labour hours 10,000 90,000

10. Belring, Inc. (continued) Predetermined Overhead Rate = Budgeted overhead  Expected activity = $360,000  100,000 DLH = $3.60 per DLH

11. Belring, Inc. – Unit Cost Computation:Plantwide Rate CordlessRegular Prime costs $ 78,000 $ 738,000 Overhead costs: $3.60 x 10,000 36,000 --- $3.60 x 90,000 --- 324,000 Total mfg. costs $114,000 $1,062,000 Units produced  10,000 100,000 Unit cost $ 11.40 $ 10.62 ======= ========

12. Functional-Based Costing:Departmental Rates Overhead Costs Assign Costs Stage One: Pool Formation Department A Pool Department B Pool Unit-Level Drivers Assign Costs Assign Costs Products Stage Two: Costs Assigned Products

13. Belring, Inc. – Departmental Data FabricationAssembly Budgeted OH $252,000 $108,000 ======= ======= Expected and actual usage (DLH): Cordless 7,000 3,000 Regular 13,000 77,000 20,000 80,000 ===== ===== Expected and actual usage (MH): Cordless 4,000 1,000 Regular 36,000 9,000 40,000 10,000 ===== =====

14. Belring, Inc. – Departmental Rates Overhead Rates: Fabrication Rate = Budgeted OH / Expected MH = $252,000/40,000 = $6.30 per MH Assembly Rate = Budgeted OH / Expected DLH = $108,000/80,000 = $1.35 per DLH

15. Belring, Inc. – Unit Cost Computation: Departmental Rate CordlessRegular Prime costs $ 78,000 $738,000 Overhead costs: ($6.30 x 4,000) + ($1.35 x 3,000) 29,250 --- ($6.30 x 36,000) + ($1.35 x 77,000) --- 330,750 Total mfg. costs $107,250 $1,068,750 Units produced  10,000  100,000 Unit cost $ 10.73 $ 10.69 ======= ========

16. Symptoms of an OutdatedFunctional Cost System • The outcome of bids is difficult to explain. • Competitors’ prices appear unrealistically low. • Products that are difficult to produce show high profits. • Operational managers want to drop products that appear profitable. • Profit margins are difficult to explain.

17. Symptoms of an Outdated Functional Cost System (continued) • The company has a highly profitable niche all to itself. • Customers do not complain about price increases. • The accounting department spends a lot of time supplying cost data for special projects. • Some departments are using their own accounting system. • Product costs change because of changes in financial reporting regulations.

18. Belring, Inc. – Activity Usage CordlessRegularTotal Units produced per year 10,000 100,000 110,000 Prime costs $78,000 $738,000 $816,000 Direct labour hours 10,000 90,000 100,000 Machine hours 5,000 45,000 50,000 Production runs 20 10 30 Number of moves 60 30 90

19. Belring, Inc. – Additional OH Cost Data ActivityActivity Cost Setups $120,000 Material handling 60,000 Machining 100,000 Testing 80,000 Total $360,000 =======

20. ABC: Two-Stage Assignment Cost Of Resources Direct Tracing Assign Costs Driver tracing Activities Assign Costs Driver Tracing Products

21. Belring, Inc. – Activity Rates Activity rates are computed below: Setup rate: $120,000/30 = $4,000 per run Material-handling rate: $60,000/90 = $666.67 per move Machining rate: $100,000/50,000 = $2 per MH Testing rate: $80,000/100,000 = $0.80 per DLH

22. Belring, Inc. – Activity-Based CostingUnit Cost Computation CordlessRegular Prime costs $ 78,000 $ 738,000 Overhead costs: Setups 80,000 40,000 Material handling 40,000 20,000 Machining 10,000 90,000 Testing 8,000 72,000 Total mfg. costs $216,000 $ 960,000 Units produced  10,000 100,000 Unit cost $ 21.60 $ 9.60 ===== =====

23. Comparison of Unit Costs CordlessRegular Plantwide rate $11.40 $10.62 Departmental rate 10.73 10.69 Activity rate 21.60 9.60

24. Activity Categories Unit-level Activities are those that are performed each time a unit is produced. Examples: Power and machine hours are used each time a unit is produced. Direct materials and direct labour activities are also unit-level activities, even though they are not overhead costs.

25. Activity Categories (continued) Batch-level Activities are those that are performed each time a batch of products is produced. Examples: Setups, inspections, production scheduling, and material handling.

26. Activity Categories (continued) Product-level (Sustaining) Activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold. Examples: Engineering changes, and expediting.

27. Activity Categories (continued) Facility-level Activities are those that sustain a factory's general manufacturing processes. Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.

28. When To Use An ABC System Measurement Cost Cost Error Costs Optimal Cost Level Low High Level of Accuracy

29. Comparison of JIT withTraditional Manufacturing JITTraditional 1. Pull-through system 1. Push-through system 2. Insignificant inventories 2. Significant inventories 3. Small supplier base 3. Large supplier base 4. Long-term supplier contracts 4. Short-term supplier contracts 5. Cellular structure 5. Departmental structure 6. Multiskilled labour 6. Specialized labour 7. Decentralized services 7. Centralized services 8. High employee involvement 8. Low employee involvement 9. Facilitating management style 9. Supervisory management style 10. Total quality control 10. Acceptable quality level